FASB edits hedging standard, more changes to come

The Financial Accounting Standards Board has finalized a change to the new hedge accounting standard that expands the list of permissible U.S. benchmark interest rates.

FASB approved Accounting Standards Update No. 2018-16 to revise the rules under Accounting Standards Codification Topic 815 on derivatives and hedging to address concerns about benchmark rates that could be applied under new guidance, which takes effect Jan. 1, 2019. As companies prepare for the new hedge accounting standard, FASB heard concerns about rates permitted under the standard, prompting the amendments.

Under U.S. GAAP rules regarding hedging, eligible benchmark interest rates are those rates on direct U.S. Treasury obligations, the London Interbank Offering Rate (LIBOR) swap rate, and the Overnight Index Swap (OIS) rate based on the Fed Funds Effective Rate. The new body of hedge accounting rules under ASC 815, which FASB finalized in 2017, also permits companies to apply the Securities Industries and Financial Markets Association Municipal Swap Rate for hedging purposes.

Wider systemic concerns regarding the sustainability of LIBOR prompted the Federal Reserve Board and the Federal Reserve of New York to identify the Secured Overnight Financing Rate (SOFR) as a preferred alternative reference rate. That prompted FASB to add the OIS rate based on the SOFR as a permitted U.S. benchmark interest rate to facilitate the rate transition and provide lead time for companies to prepare their interest rate risk hedging strategies under the new standard.

FASB is still working on other changes to the hedging standard, most notably a clarification on which instruments meet the definition in the standard for prepayable financial instruments, which is an important preliminary step in determining eligibility for hedge accounting. FASB has indicated it regards prepayables as any instruments that are exercisable and prepayable at any time, those with certain contingent prepayment terms and those with conversion features.

The board also is working on new guidance to clarify aspects of the last-of-layer method introduced with the new hedge accounting standard. Preparers have told the board they’re looking for guidance on how and when an entity can or must allocate the last-of-layer basis adjustment to individual assets or sub-pools within a closed pool. They’re also asking for a clarification on whether entities can use a multiple-layer hedging strategy with respect to a closed portfolio.

FASB and its staff are continuing their work on those additional pieces of guidance.